Microfinance Focus, January 01, 2011: Chennai based IFMR Capital has invested in an INR 165.5 million securitization transaction backed by 25,768 microloans to a Bangalore based Microfinance institution, Grameen Financial Services P. Ltd., popularly known as Grameen Koota.

The loans were arranged and invested by the company for their undeterred belief in the sector and their aim at providing efficient and reliable access to capital for institutions benefitting low-income households.

The transaction structured as par with turbo amortization was credit enhanced through cash collateral from the originator, EIS from pool cash flows and second loss credit enhancement from IFMR Capital. The senior tranche rated P1(so) was bought by one of the largest NBFCs in India. IFMR Capital invested in the subordinated tranche.

Microfinance Focus December 29, 2010: Stung by an industry-wide liquidity crunch and abysmal repayment rates in Andhra Pradesh, Microfinance Institutions (MFIs) are facing yet another blow. Microfinance Focus has learned of a large number of employees being laid off by some MFIs.

As per sources, more than 500 loan officers have been laid off by one of the biggest microfinance companies in Andhra Pradesh. Another Tamilnadu-based MFI also took this serious step and reportedly laid off many of its loan officers. The reasons for the layoffs are believed to be efforts to reduce costs. Many MFIs have also postponed employees’ promotion and have extended the probation periods of recent hires..

“We were completely dependent on this sector for our employment and it was much unexpected to come across a disappointment like this,” said a former employee of a major MFI in AP adding, “Some of us have now begun looking out for jobs outside the sector itself, owing to the uncertainty in jobs in the MFI sector.”

The current ranks of middle management of many of the MFIs located in southern states also face uncertainty with regards to their future careers in the sector.

As a matter of fact, the Microfinance sector is responsible for significant employment, especially among the rural youth of India. According to the latest figures published on company websites, 21,154 staff are employed at SKS, 10,400 at Spandana, and 6,467 at Share. Combined, India’s largest ten MFIs provide employment to approximately 60,000 people in all. Industry experts also suggest that the sector employs more than 1,50,000 people.

Microfinance Focus December 29, 2010: Fatima Mansoori applied for a loan of Rs 25,000 from a microfinance institution in Bangalore for the purpose of starting a grocery store in her neighborhood. She was able to pay up the loan in time and was quite satisfied with the services provided to her by the institution. However, her suggestion in the institution’s weekly meeting was that she be granted loans of higher amounts for the expansion of her business in the future.

“I was able to start a grocery shop by acquiring a loan amount of Rs 25, 000 from my institution; however I aspire to obtain a loan of higher amounts to be able to make more money and expand my business. With this loan I’m sure to be able to make the kind of purchases I have already thought of for my business,” said Mansoori.

At the weekly meeting, the women shared the opinion that the loans sanctioned to them benefitted them in many ways. While there were some who had applied for emergency loans there were also others who had applied for supplementary loans.

Furthermore, the women demanded to be able to receive education on the health issues and financial aspects. They also wished to acquire training on new skill and business development.

Microfinance Focus, December 28, 2010: Microfinance Focus recently floated an open discussion on LinkedIn to gauge industry perspective on – ‘What are the Crisis Management Measures microfinance institutions should take to sustain and keep going in turbulence time’. The discussion received a fervent response from microfinance stakeholders including practitioners, advisors and funders. Edited excerpts of their recommendations:

Brahmanand Hegde, Founder-Director at Vistaar Livelihood Finance, Mumbai

MFIs work with mass market where the interest of other stake holders is high. Therefore, crisis management needs to have two parts. One is internal to MFI in terms of transparency, governance, products, tech architecture, MIS, cash flow management etc. But, I feel, likely danger/crisis going forward is from external stakeholders. This could be managed better through being transparent, value adding and taking other stakeholders into confidence. Above all stronger bonding with customer is key for long term sustainability.

Saswati Mahapatra, International Database Manager, Haver Analytics and Faculty at Online School of Business at University of Phoenix, New York

If crisis means delinquencies than the answer is more scenario analysis of political effects, contagion affects, local geopolitical events, environmental crisis, and economic effects to ensure capital adequacy. MFIs’ clients seem to be geographically concentrated.

If crisis means bad publicity, then answer is good PR and measurable/sustainable development goals.

I think the microfinance industry, especially in India, have become big a systemic risk. Therefore there is need for good information system within an institution as well as information sharing in the industry.

John Bliek, MF and BDS advisor at NGO, Netherlands

Communication with staff is important, train them on customer relations and review critically your incentive system on different levels. Step back to the basics, which is providing a service to help poor customers.

Niranjan Sheelavant, Social Entrepreneur & Value Added Service Provider, Bengaluru

These are some of the insights gained during a workshop:

• Stop-watch and go. Revisit your Business Plan, moderate your growth and get ready for de-growth phase

• Do a thorough Risk Profiling – territory, portfolio, product, processes, etc.

• Put in place a special cell to monitor risky and problematic portfolio

• Revisit training strategies and invest in HR

• Invest in innovation and experiment in alternative models

• Cut your cost, without any mercy! Start from the top, not from bottom.

• Carryout impact studies to validate explicitly stated goals

• Build core values and ethos of your company

• Shift to other markets

• Move up the value-chain

Ultimately, the last mile is MFI staff, not clients.

Pon Aananth, South Asia watercredit officer at water.org, Tiruchchirappalli

• MFIs should follow organic growth and ensure that quality brings growth and not the other way.

• Revisit the client relationship – MFIs should identify ways, which will strengthen MFIs and clients relationship.

• MFIs should diversify its product offerings and allow standardized loans products should go

• CGT – should talk more about the MFIs social mission and similar other stuffs than loan products, ROI etc..,

Ascanio Graziosi, Founder, CDB Microfinance

In our opinion problems are about who – the practitioners who sanctioned unsustainable credit – and how – the credit model adopted.

In the common language, microfinance means everything and the opposite of it. However microfinance practitioners shouldn’t take advantage of an ordinary mystification. In other words, the mixture between commercial and social hasn’t been well balanced.

This means that practitioners have to revise the way of doing business and credit models should be revised. Above all, at country level it is necessary to translate into practice the “Core Principles for Microfinance Industry” approved last November in Seoul by G20 Group within the frame of Basel III regulations.

Chandan Batsayan, Associate Regional Manager-Rural Business at ICICI Prudential Life Insurance, New Delhi

In addition to what has been stated by esteemed members, I think the present crisis requires an MFI to develop a comprehensive framework for stakeholder’s management. An enterprise can remain an ongoing concern only if it serves the interest of its constituents in fair and transparent manner. Hence it is equally important for an MFI to focus on the followings,

• Corporate governance: Transparent and ethical conduct must be the cornerstone of an enterprise in general and social enterprise in particular. Most of the Indian MFIs are still individual-centric and hence there is a natural tendency amongst the management to fall in line with the individual than of being system and process driven.

• Missionary approach: MFIs need to understand the critical mission they have set out to achieve. Any drift into it is going to meet with the kind of knee-jerk reaction we are witnessing today in AP.

In a nutshell, profit is good but an inexplicable act of profiteering will prove counterproductive.

Ramakrishnan Venkateswaran, Co-founder & Director M Power Micro Finance Pvt. Ltd, Mumbai

There is a famous Chinese curse “Let there be interesting times”. The one who used the quote meant that the other person faces interesting times i.e., Crisis. However, the more enterprising of the Chinese took this as a positive comment and took the challenges head on. They were rather prepared for such events before hand and then came out trumps. Another Chinese interpretation of the word “Crisis” is that it has two sides, one meaning “Danger” and the other meaning “Opportunity”.

In the present context, the MFIs should consider both the sides and be ready. They need to measure the Danger and be ready to face such situations time and again. It is but natural to expect these situations (The A.P like situations) to re-visit in many forms and many times again. This is an Opportunity because they are required to re-visit their models and work towards making robust organizations. There is no opportune time than the current period. They cannot make an organization robust without getting the trust of the Fulcrum of the Crisis i.e., the customer. If they are able to do this then there would be more interesting times one which is generally positive.

Mohsin Ahmed, Chief Executive Officer at Pakistan Microfinance Network, Pakistan

As is see it, we need to segment this in terms of kind of crisis. If this is the credit risk and it is spreading out at the industry level then the most important things to do are:

1. Acknowledge that there is a crisis – acknowledgement should be both by the MFIs affected and of the causes (especially if these are internal to organization or industry)

2. All MFIs need to come under the umbrella of their national network/association and decide on how to tackle this issue – one way of doing this is to give clear cut message that defaulters will not be lent by the sector unless he/she clears the loans; we can also decide to take a few defaulters to task by taking them to courts and sending out a clear message that we mean business.

3. Plan for the next crisis and this mean doing following:

• Accepting mistakes and committing to address them at the MFI and at the industry level

• Setting up of a Credit Bureau and developing lending codes with monitoring and implementation system

• Developing code of conduct for consumer protection and ensuring that a mechanism is put in place to monitor its implementation

• Setting up of a grievance cell – this cell must listen to the complaint of clients and if possible MFIs also

• Revisiting our value proposition (why are we so weak to external pressures; especially given we claim changing lives of the poor)

(Disclaimer: The opinions expressed are solely those of the authors and do not necessarily represent opinion of their organizations. Microfinance Focus does not take any responsibility for correctness of the data presented by contributors)

Microfinance Focus, December 28, 2010: Peruvian BBVA Microfinance Foundation, a stockholder of Caja Rural de Ahorro and Crédito Nuestra Gente (CNG), has recently signed an agreement to acquire Financiera Confianza and subsequently merge Financiera Confianza with Caja Nuestra Gente to form a bank.

Caja Nuestra Gente (CNG) was created in 2008, after the acquisition and merger of Caja Rural NorPerú, Caja Rural del Sur and Edpyme Crear Tacna. As in December 2009, CNG had a total assets worth $240 million and more than 97, 000 active borrowers. The organization’s gross loan portfolio stood at $187 million.

BBVA Foundation is also present in Colombia, where it operates with Banco de las Microfinanzas Bancamía, in Puerto Rico with la Corporación para las Microfinanzas, in Chile with Servicios Microfinancieros S.A., and in Argentina with the company Servicios Microfinacieros S.A.

By Sanjay Behuria,

Microfinance Focus, December 28, 2010: What is being termed as the death of microfinance is really the death of microfinance institutions. As long as there are poor people in need of capital to eke out a living – microfinance will exist. In the wake of the AP Government ordinance – now Bill, on MFI activity in the state, questions are being asked by all stakeholders whether MFIs are moneylenders working in the guise of social activity – wolf in sheep’s clothing? This paper is being written after making intensive visits to the field and interviewing various stakeholders. There are two major questions that will be answered during the course of this paper – whether some MFI’s  killed the golden goose in their quest for quick money and whether the rest of the MFIs continued to see the naked emperor in  clothes until the government removed the wool from their eyes?

What is Microfinance?

Microfinance has evolved as an economic development  approach intended to benefit low-income women and men, mostly women. The term refers to the provision of financial services to low-income clients, including the self-employed. Financial services generally include savings and credit; however, some microfinance organizations also provide  insurance and payment services. In addition to financial  intermediation, many MFIs provide social intermediation services such as group formation, development of self confidence, and training in financial literacy and management capabilities among members of a group. Thus the definition of microfinance often includes both financial intermediation and social intermediation. Microfinance is not simply banking, it is a development tool.

Microfinance activities usually involve:

• Small loans, typically for working capital

• Informal appraisal of borrowers and investments

• Collateral substitutes, such as group guarantees or compulsory savings

• Access to repeat and larger loans, based on repayment performance

• Streamlined loan disbursement and monitoring

• Secure savings products.

Although some MFIs provide enterprise development services, such as skills training and marketing, and social services, such as literacy training and health care, these are not generally included in the definition of microfinance. BASIX has pioneered these services under the name of livelihood promotion services, and bundled it with its credit services – known as credit plus services, as also some services independent of credit.

What is an MFI?

An MFI is an institution that delivers microfinance, mostly microcredit at cost plus and recovers the principal along with interest. An MFI can be a NGO (society or trust), a not for profit company, a NBFC, a co-operative, or a Bank.

Who are the clients?

The clients of MFIs are those who have an economic activity that has a gap in it’s cash flow and therefore needs funding to plug the gap to complete the economic/production cycle for the most effective result. Such gap can be a shortage of combination of financial and non-financial inputs. Their needs are however small -micro and therefore too cumbersome for commercial banks to handle. Any credit need below Rs. 50000 is defined as micro-credit. However, the ultra poor who do not have an economic activity are not microcredit clients, primarily because the borrowed money cannot result in generating positive cash flow in the absence of economic activity. There have been questions about microfinance being used as consumption expenditure by clients. The test here is that microfinance looks at the entire cash flow of the client in a holistic way and is not targeted to cash flow from any particular activity. For instance, if a borrower has an economic activity, but is unable to attend to it due to health reasons and needs a health related loan so that they can return soonest to continue their economic activity – this would be an eligible microfinance loan.

MFI funding strategy?

In the early days MFI loans were made out of grants and charities. There are still many MFIs known as NGOs who use grant funds for their MF lending. Some have leveraged the grant fund to borrow from banks to on lend. The for-profit MFIs invite private capital to build an equity base. They then leverage this equity to borrow from banks up to 6 times the capital to onlend.  In both cases the donor grant and the private equity is only 15% of money lent to the sector. The other 85% comes from Banks which are depositories of public money. It is therefore erroneous to suggest that private capital is the mainstay of the MFI funding strategy. However, private capital is the mainstay of drive for profits which has led to the current crisis. The classic case of killing the goose that lays golden eggs. Instead of looking after the goose which can continue to lay the golden eggs for all stakeholders, the controlling institution (MFI) kill the goose in the hope to get all that is inside, in one stroke.

MFI business strategy?

The current business strategy of most MFIs, especially the for- profit MFIs is to scale up and be sustainable. What this has meant is expand portfolios at a scorching rate and charge whatever and in whichever name as long as no one is objecting. Back this up with social collateral or group guarantees, in whichever name we call it, and lend on the basis of this collateral, while the original premises was to lend to meet cash flow demand of the borrower’s business cycle.  This has led to multiple lending and multiple charges resulting in overall dissatisfaction. The ordinance has given vent to this pent up feeling which has been reflected in recoveries.

The game is played by capitalists in the guise of social entrepreneurs who invite private capital looking for extraordinary profits. Promise them a return on asset of 6%. Show them a leverage that is six times equity. With Banks having to lend 40% of their portfolio to the priority sector and preferring the indirect mode , this is easily done. End up with a return on equity of 35% and invite more private capital in the name of scaling up. As a result of this, private capital recovers its investment in 3 years and all that is left in the cycle is 100% public money from Banks. This is the time to kill the goose that lays golden eggs. Increase your margins further, show super extraordinary profits and milk as long as possible until the administrators’ cry- but the emperor is wearing no clothes. Time to hide your nakedness. The bad ones run away, the good ones get new clothes to survive and the financial system is stuck with public money indiscriminately loaned out in the chase for super profits by private equity that cannot be recovered.

How the super profits are earned?

The MFIs earn revenues from:

• Interest

• Loan processing fee

• Cash margin

• Commission from value added services – insurance, providing technical assistance, capacity building

The MFIs are accused of earning super profits through high interest rates and imposing other fees and being non-transparent in how they charge their clients. There is no equivalent to “Truth in lending”. Thus MFIs charge interest rates either on flat (on loan amount regardless of outstanding) or declining (interest on outstanding balance). They also calculate or compound on daily, weekly or monthly basis. Thus a nominal rate of interest without the qualifications of how it is calculated, does not reveal the real interest rate.

Thus far MFIs have justified the high interest rates, quoting various reasons:

• They are lower than moneylenders – as if that is sufficient reason for charging high interest rates for the benefit of private capital in the guise of social capital

• They are lower than government rates, when bribes, delays and travel costs are taken into account

• The cost is high as the MFIs are not allowed to take deposits and lend borrowed funds

• The cost of delivery is high as the transaction costs are high due to the volume and door step delivery

• The poor can pay – so why not charge them

Thus they charge 24% (or thereabout) interest, which is explained as:

• Cost of funds 14%

• Cost of operations 6%

• NPAs 1 %

The above calculation leaves them a return on asset of 3%.

In the above justification, there is no mention of what is reasonable. According to this author since the MF sector is in the financial sector, the average return on assets of the banking sector can be used as a bench mark for assessing reasonable profit. There may be a case for benchmarking prior to adjustment of NPAs as the MFI sector claims lower NPAs than the banking sector and will be entitled to the higher profits for their efficiency.

They also charge a loan processing fee which can go up to 4% for some.

What is loan processing fee? The MFIs will find it hard to explain the loan processing fee when they account for operations cost in the interest rate. Is the loan processing done by an outsider to whom they have to pay a fee for which they recover from the client? If not what is the basis of the fee – is that not double counting for their operations cost and therefore usurious? Do the MFIs shorten the term of their loans so that they can earn the fee more often when a loan is repeated? Does the shorter term of the loan increase the amount of repayment of principal, thus burdening the borrower to repay faster than its generation of cash flow? In the end does it violate the purpose of the loan and force the borrower to seek cash from another source to repay the demands of the first loan which should have come from the cash flow of the economic activity? Do the MFIs in their quest for faster and higher income, force the borrower to violate the basic principle of a micro finance loan? Then, how can they say that the government or an ordinance or an external stakeholder is responsible for killing microfinance? Have they not hanged themselves by breaking their own principles which led to financial, economic and social success in the earlier years? Did the government expose the emperor or the emperor was never wearing any clothes? These are the questions that must be answered if microfinance is to re-emerge from the mess that it is, for the benefit of all stakeholders.

Cash Margin:

When an MFI makes a loan it insists that the borrower puts up ten percent in the name of equity for equity. This is a fair practice – as long as the borrower’s equity is employed in the business – as her stake. Instead, the MFI takes this in as a security deposit at a low interest rate and uses it as a funding resource. By doing this the MFI squeezes its own borrower’s working capital and puts at risk the repayment capacity of the borrower through under-financing of their cash flow requirements. It also increases the overall cost of the borrower and fattens the profits of the MFI as this deposit is cheaper than borrowing from banks.

Commission from value added services:

This is a fair charge as long as value is being added. It must be remembered that all services start with good intentions. However, all solutions become the next problem. Also, all solutions have both intended and unintended results. These are natural principles, which we cannot argue with. We can pre-empt and deal with them to the best possible extent that more of intended results flow from such solutions. To calculate them as hidden interest income is also not fair, either to the borrower who needs the services or to the service provider.

Multiple lending:

Currently, multiple lending is being viewed as the scapegoat for all the woes of the MF sector as it may in some cases result in over indebtness. What is multiple lending? Multiple lending happens when many agencies lend to the same entrepreneur for the same activity leading to over finance. Over finance may lead to the start of a new activity, scaling up the existing activity or siphoning off the excess supply for consumption purposes. When the latter happens the borrower uses one source to repay another source and becomes perennially short in cash flow to repay all their obligations. Is multiple lending bad when the borrower is unable to meet the cash flow need from a single source? Do not the large business and small businesses use multiple financing for their businesses when they are underfinanced? As the micro loans are often limited and many micro businesses have additional needs, a single source of supply cannot meet their cash flow needs. Therefore, what needs to be investigated is whether borrowers are underfinanced or over financed. Once that is determined then and then can the vicious cycle of multiple lending be rectified. There will be a need for co-operation of all lenders to start a local credit bureau to share lending information rather than burdening the borrower to go to every lender to obtain a no objection certificate.

Collection practices:

Ever since banking started bankers have needed to visit the borrower on site. This has been required both at the pre-sanction and the post-sanction phase. At the pre-sanction phase it is required to know the place of work of the borrower, to understand the activity and the working capital cycle. To assess the borrowing capacity and evaluate the existing assets. Similarly, at the post sanction phase inspections are carried out to check out the assets, the continuation of activity and for technical assistance. Even if the incidence of excesses in recovery are true, we cannot throw out the proverbial baby with the bath water. If we did, then lending activities will stop as recoveries dwindle and the real sufferers will be the micro entrepreneurs in dire need of capital. Instead, it will make sense to always visit the borrowers in groups where witnesses are available or always invite the neighbors while making site inspections. Any complain must be investigated and the culprits punished accordingly. Personal contact and relationships are an integral and significant part of lending and recovery without which the business will die a swift death.

Joint liability group, co-obligates

The current MF structure is heavily based on peer group social collateral to assure repayment of debt. This has worked well over the last thirty years, but now seems to be crumbling under its own weight. Any leverage is a double edged sword. When capital is leveraged ten times, every rupee earned on assets returns ten rupees on equity. Conversely, every rupee lost on asset results in a ten rupee loss of equity. The current crisis has witnessed that many borrowers are themselves not reluctant to repay, but are not repaying under social pressure.

Joint liability per se is not a sufficient reason for repayment potential. It is only a collateral, even if social, and is secondary guarantee to the cash flow generated from the loan. It is again an unintended result that JLG which was meant to be a collateral has become the primary purpose of a loan. If you have a JLG, you have a loan. Without a purpose, an activity, a cash flow, loans are given as long as JLG exists. What is a secondary reason for repayment, has become the primary purpose of the loan. The only assurance of repayment can come from cash flow from the activity, and therefore it becomes necessary to do individual loans without collateral for microcredit.

Compassion:

Many borrowers complain about how the MF system has lost the human touch and is too mechanical. The MF recovery practices have a fixed date and fixed amount and regardless of the situation of the borrower the money is demanded, even when unforeseen calamities have destroyed the assets of the borrower. There is little scope to understand the borrowers changed circumstances and make adjustment to the repayment obligations leading to distress. Most field staff will answer the borrower, “My system does not allow repayment scheduling – if you don’t pay now, I will not know what to do next.”

What next?

As long as micro entrepreneurs exist and have a shortage of capital to meet their business needs micro finance will exist. It has morphed over thousands of years from simple money lending to micro finance as it existed before the ordinance. At every stage there have been shenanigans who have crossed over from being do gooders to evil doers and killed the golden goose. However, such acts have every time  pulled more do gooders to fill the vacuum, and this time there will be no difference. Let us now look at the possible future of the sector and how the funding and associated needs of the business at the base of the pyramid will be met.

We have already established that the existence of private capital is more myth than reality. Most of the MFI portfolio as they exist now is either grant money or public money. The banks who have employed the public money have taken little responsibility to protect the public money and have basked in the successes of the MFIs doing all the work while they have achieved their priority sector targets and earned decent spreads. This story is now dead. The banks must now take direct responsibility for the deployed funds as the collection of those funds can only lead to further lending.  The story so far is that Banks do not know the nitty gritty of microfinance and the MFIs do not have the funds. So the partnership model was the perfect opportunity for both parties to meet their objectives. The third factor that impinged on the current model is the greed of private capital. The answers therefore must lay in continuing the banks to achieve their objectives with higher accountability and responsibility, allowing MFIs to do the job they know so well – without the control over the portfolio and eliminating private capital that comes attached with greed. Any private capital that is willing to invest at a bench marked return and improve on that through introduction of innovation and efficiency, needs to be embraced. There are two possible models to achieve the above objectives.

The first model is – continue the existing model with caveats. A’ truth in lending’ rule must be adopted which will define every aspect of lending for transparency.

Interest rates – while no caps may be prescribed the interest rates charged must be transparent. All MFIs  will align their interest rates to the standard format – calculate interest rates on daily balances and apply monthly.  They must also clearly specify the all in charge – a finance charge which includes – cost of funds, the operations cost as per last financials reduced at an interest rate percentage, average NPA and desired profit. The desired profit as explained above is a benchmarked rate of the financial sector of the country. There is often criticism about the NPA of MFIs . Using NPA to determine the finance charges will work to negate the perception that NPAs are manipulated. If a MFI declares a low NPA then they lose out on interest rate, if they declare a high NPA, their credit rating suffers.

Loan processing fee: This needs to be eliminated as they are already built into the operations cost. Any institution collecting LPF must be able to justify the additional cost apart from operations cost for his item.

Cash margins: They serve no purpose except to make the loans more expensive and under finance the business cycle by squeezing the cash flow, and therefore needs to be eliminated. However, the borrower may be asked to meet 10% of their financing needs and the fund needs to be in the business rather than sit with the MFI.

Value added services (VAS): While value added services are useful for efficiency, the manner in which they are currently done has led to a perception of manipulation of the borrower by bundling VAS with credit. To delink, the VAS needs to be sold prior to credit or post credit – as standalone services for which the borrower volunteers.

Multiple lending: At no stage must the total repayment of the borrower for all credit needs exceed 40% of their total cash flow generated during the repayment period. This is difficult to apply in the absence of a bureau where credit records of individual borrowers can be obtained. It is suggested that simple credit bureaus are established at Gram Panchayat levels. Since micro finance borrowers obtain credit at home and there is almost no cross over from one village to another to obtain credit, a national bureau is not required. All MF operators may agree to supply data of all their borrowers at a single point. Any lender must obtain full village data of borrowers before undertaking credit in any village. If they undertake any lending, the data must be immediately supplied to this point. This data will help the lender to limit total lending to 40% of the cash flow need of the borrower through an appraisal system that is standardized across MFIs. Since the funds essentially belong to banks, the banks must supervise this activity – the lead bank of a district will be an ideal candidate to supervise this.

The first model does not introduce higher responsibility and accountability of the primary lending institution whose funds are employed by the MFI and therefore is prone to negligence, misuse or even abandonment. The second model proposed here aims to overcome the shortcoming by placing the portfolio with the primary lender.

The MFIs become business correspondents of banks. However, they need to have a stake in the business and therefore provide 10% of the portfolio from their own equity. The entire portfolio sits in the bank as its own assets. The BC is compensated for all its costs and a desired profit which is benchmarked to the overall financial sector profits as already discussed. The compensation is also stepped down as per a declared quality of assets agreement. In this model the MFIs can collect savings for the principal agency and facilitate the transaction of the entire suite of financial inclusion services and provide access to finance, thereby further bringing down costs.

In the BC model the finance cost for the loan can be reduced to 16% for the beneficiary by taking out the MFI as intermediary. This is based on the theory that if a manufacturer can sell a unit of its product at the same price (MRP) regardless of its site of production, why do Banks have to charge different rates to different clients based on their location. The entire cost of operations should be divisible equally between all its clients. When the banks claim that MFI loans are about 2% of their portfolio and they reimburse 7% of portfolio ( 6% operations cost and 1% profit) as BC expenses, the cost of operations for MFI loan is 7/50 or a negligible 0 .14%. In this example the BC earns 9% on its equity from the Bank as well as minimum 16% on its lendable funds). This becomes important as the banks are making the loans out of deposits, which are coming across from various locations. Statistics will prove that rural centers have a more positive CD ratio than urban centers – yet rural clients pay more for receiving their own money! Thus the rate that will be charged will be a sum of and will be known as finance charges:

• Lending Cost or interest rate – 13%

• NPA cost – 2%

• Operations cost 0.14%

• Risk fund for mitigating distress – 0.86%

• Total cost to borrower – 16%

The above is not a ceiling rate, but a desired rate based on the overall market condition. There may be reasons to charge more than this. Since this portfolio is 100% risk weighted, a charge for blocked funds compared to other loans will be justifiable. Similarly, higher loan loss probability charge – this will not be possible if on time recovery of this portfolio is 99% and other portfolio where such loan loss charge is not levied is at 97%. As long as such charge is explainable and reasonable as per such explanation, it may be included in the finance charge.

A financial institution needs to make a distinction between interest charge and finance charge. Interest charge is only a cost of fund and a component of finance charge. All other charges will need to be clearly mentioned in the total of finance charges for reasons of transparency. In such a situation, the FI can answer the criticism of usurious rates charged to MF borrowers.

In both cases the operations cost is made transparent by making public the top ten salaries of the MFI. It is understood that the compensations are not capped but standardized. Again a financial sector benchmark may be used. Any large discrepancy in the salaries of the top people will immediately be noticed by all stakeholders. Also, the percentage share of the top 10 versus total HR cost will help to deflect criticism about the profits being siphoned off as shareholder salaries.

To be compassionate and earn the goodwill of the borrowers it is suggested that all MFIs contribute 1% of their profits, which can be added to the interest rate and build a corpus to help distressed borrowers in times of need. This fund is to be administered by independent ombudsman, who will go into each distressed case and deal with them as per clearly laid down eligibility guidelines. If such a fund existed, the MFIs would not have been blamed for the unfortunate suicides, which may or may not have been solely due to repayment demand abuses.

To save the micro entrepreneurs, to continue to strengthen the intended results of MF activity, it is now imperative that MFIN and Sa-Dhan work together. Set up clearly laid down guidelines with all MFIs as signatories and government intervention against any violating member. Meet with the government and the other stakeholders at the top level and get back to business. Otherwise, they are in danger of falling prey to demagogues who play the short term game and invite disaster to the financial fabric of the country. All must realize that the collapse of the financial fabric of the country, the banks, the intermediaries and the beneficiaries are in no one’s interest – they only feed the demagogues. The question is not whether the business will go on – it is a question of how it will be done and for whom. What is the highest purpose of micro finance – let us all get back to achieve that purpose. We have forgotten the basics, time to get back to basics.

Acknowledgments;

Mr. Vijay Mahajan, The Chairman BASIX and colleagues at BASIX India for their time and in-depth knowledge sharing.

About the Author: Sanjay Behuria is an Independent Director with KBS LAB – A BASIX group Banking Company under BRA (Banking Regulation Act). He is an independent strategy consultant in access to finance and enterprise development.

(Disclaimer: Views expressed in the article by the author are his own and do not necessarily represent those of Microfinance Focus. Microfinance Focus does not take any responsibility for correctness of the data presented by contributors.)

By G K Agrawal,

Microfinance Focus, December 27, 2010: Editorial Note : As a rejoinder to the Articles on Micro-Finance published in ET Mum dated 11 and 12 November 2010, the following additional issues considered relevant to MFIs are discussed briefly:

Over the years, a few models of MFI lending viz., SHG banks linkage programme evolved, promoted and supported by NABARD with 100% refinance support coupled with capacity building measures, Grameen model, without profit NGOs’/ non profit companies led MFI lending and with profit new generation NBFC –MFIs have evolved. The present controversy is mainly related to working of with profit NBFC MFIs and the observations mainly relate to their working and methods of operations.

MFIs especially those working in AP are themselves to be blamed for inviting State Govt. wrath in the form of an Ordinance for regulating their activities due to their ever increasing Greed for larger income to offer better return of equity and  alluring investment from equity/venture funds, excessive rates of interest  on mf lending under the pretext of sustainability of their operations and cost of funds/management,  without any regard to their affordability to the borrowers, multiple lending to increase volume of credit without linking to repaying capacity of borrowers, window dressing of recoveries and using of strong arm methods to recover their dues etc.

Recent reduction twice in interest rates on lending su – motto by SKS Finance has exploded the myth that MFIs require very high rates of interest to be charged on their lending to sustain their operations and confirming the view that there is a scope for downward revision of interest rates on MF lending. There is a need for greater transparency, in regard to raising resources, cost of management, charging of interest rates, penal interest, other penalties, pricing policy, etc. While the financial viability of the MF service providers has to be ensured, and the   rates of
interest need not be regulated and can have their forbearance, there has to be some voluntary code of conduct among service providers in this regard. They should not be perceived as being built up at the cost of poor who have no bargaining capacity and have very limited options for access to finance. Broad Parameters for cost of management and lending rates   need to be evolved.

Dr. C Rangarajan, Chairman of PMEAC is also reported to have recently observed that while MFIs have an important role to play in financial inclusion, the high interest rates which they charge could hamper their cause. He also observed that it is important that the rate of interest they charge is well within the repaying capacity of the customers. Otherwise, MFIs lose the rationale as an intermediary to provide affordable credit to consumers.  To do this, he observed that it was necessary for MFIs to separate pure interest costs from other costs charged to borrowers because of the additional services provided.

The suggestion to transform the MFI lending and linking it with livelihoods /income generation activities is to be seen with  ref. to the  holistic  an all inclusive and comprehensive approach for the family as a whole, so as to make it socially and economically an empowered family. It will require a hand hold on approach with backward and forward linkages, capacity building and training both of MFI staff and the targeted poor, proper tie up for skill and technology up -gradation, marketing, timely credit etc. Also, instead of de novo efforts being made by MFIS, it may be advisable to experiment initially on a PPP model under National Rural livelihood Mission Programme so as to gain some experience.

In view of the fast growth of the MF  sector  backed  with no collaterals, projections for continued higher growth,  keen interest  being shown by equity funds/companies both foreign and domestic and loan-able resources providers, ,  interest being shown by com. banks  in acquiring  mf loans as easy option to comply with priority sector lending, lack of monitoring of quality both in lending and recovery, problems observed in some of the states in the form of customer resistance, religious dikkats, lack of well defined regulatory system for mf sector, high cost of lending which may sometimes prove counter -productive,  lack of measures to ensure avoidance of  excessive indebtedness of the mf borrowers, political risks, labour problems,  lack of  adequate technical, professional backing and support, risk of business failure,  unhealthy competition, multiple borrowings resulting into debt traps and excessive lending, fears of massive delinquency,  etc., a lurking fear  is voiced in some knowledgeable quarters  that mf sector  may  burst if not regulated and monitored  effectively. There is a need for suitable proactive safety measures including restricting   members’ loan exposure to their repaying capacity and stipulating ceiling on individual loans, against possible bursting of the sector

Convenient and appropriate savings products need to be developed for the MFI clients. Also, financial inclusion has to be much wider and inclusive than merely having saving accounts and or borrowings from the banks.  . The Poor must have an opportunity to access and mediate his savings to the pool of investment that fetches him the rate of interest on his savings comparable on other saving/investment instruments available in the market, while taking care of associated market risks.   Not having a financial sector capable of doing this becomes heavily non pro – poor and iniquitous, thereby contributing economic inequality and would need proper solution.

In the context of increased migrated   rural labor to urban and semi urban areas, lack of job/income earning opportunities to unskilled urban poor, onslaught of multi – nationals etc., there is an urgent need   for improved focusing on urban poor, migrated population for micro-    financial and other interventions and improving their access to formal credit. There is a need for national level guidance, direction and supervision of Microfinance lending in urban and semi urban areas.  

While need for bringing /raising equity by commercial MFIs can hardly be over-emphasized especially when borrowings and lending are expanding,   a distinction and pro and cons may have to be analyzed between member driven equity and seeking equity support from those who may have only to pursue their commercial agenda with no real concern for social agenda. This may also cause much heartburn among NGOs who fear the social ethos of MFIs is losing out to commercial orientation profit corporations;  a balance need to be arrived at between commercial and social objectives of m f lending. Strategies   for   strengthening equity base of MFIs- member driven to avoid the risk of taking   over of good working MFIs by international/national equity companies/funds for purely commercial consideration devoid of social considerations may have to be thought of.

There is a need to appoint independent watch dogs to verify implementation of code of conduct  drawn by Microfinance Institutions Net Work (MFIN) by its member MFIs ,revisit it in terms of coverage and improving upon  further and see its efficacy and effectiveness. There is also a need to introduce social audit of MFIs . Non collateral  based lending by MFIs- though a boon for the poor but may be  a constraint for MFIs in getting rated , securitization of lending, and raising market  resources .Considering their set up, suitable norms for their ratings may have to be evolved which are acceptable to the market and the funding agencies.

Future Expansion/growth with consolidation wider base and coverage thereby reducing imbalances in regional growth, improved quality in lending and recovery , gradual switch over  from  consumption lending to productive lending, tie up for backward and forward linkages , where necessary, client protection, financial literacy, social security etc. need urgent attention.

There is an urgent need for norms and application thereof for better Corporate Governance,

Transparency, Accountability and Responsibility in MFIs, which will improve their ratings, market acceptability and credibility.  Analysis of governance and management processes   in   Indian MFIs including Corporate Governance – (understanding and role of senior management and board members, audit arrangements, consistency of the compensation approaches and ethical values of institutions, incentive structure, recovery practices, grievance redressal and transparency to borrowers etc.)  is needed.                                                              

There is a need for expeditious setting up of an independent regulatory/supervisory body for MFIs outside the proposed set up in NABARD (as its promotional and developmental interests may clash with supervisory requirements). Regulations for MFIs should include NBFC-MFIs coming at present under the purview of RBI supervision and should be different as MFIs cater to the poor and should be regarded as a social sustainable business as distinguished from the purely commercial banking operations.

How far entrance of some of the MFIs in sectors like housing,  insurance, leasing,   health services, etc., is conducive to the MFIs’ financial health and is backed by professional expertise, resources adequacy and  risk bearing capacities of MFIs vis- a- vis  associated activity/ies., need to be examined and a considered approach arrived at.

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* Mr G K Agrawal, Former Executive Director, NABARD, Rural Development and Microfinance Consultant

Microfinance Focus, December 27, 2010: International Finance Corporation (IFC), a World Bank Group is providing a €58 million loan to Bancpost S.A. that will enable the bank to finance micro, small, and medium enterprises in Romania. Bancopost S.A. is a subsidiary of EFG Eurobank Ergasias S.A. in Greece.

IFC’s support to EFG subsidiaries in Southeast Europe is part of the Joint International Financial Institution Action Plan launched in February 2009. In March 2010, Bancpost S.A. joined the IFC Global Trade Finance Program as an issuing bank to expand its trade finance operations as Romania rebounds from the global financial crisis.

IFC is also providing a loan of €38 million to Eurobank EFG a.d. Beograd, an EFG subsidiary in Serbia.  Under the Joint International Financial Institution Action Plan, the World Bank Group, including IFC; the EBRD; and the European Investment Bank pledged to provide €24.5 billion over two years to support the economies of Eastern Europe through the banking sector. A total of €27 billion had been committed as of end-August 2010.